Greg Mankiw, one of my favorite economists,
writes in
the New York Times that the cap-and-trade bill making
its way through Congress represents a ``missed opportunity''
to collect nearly a trillion dollars in government revenue.
How so? Because the bill will create permits to emit
greenhouse gases and then, instead of selling them at
auction, give them away to ``powerful special interests''.

But who are those so-called powerful special interests?
They are firms in carbon-based industries---firms whose
existing factories and machinery stand to lose a lot
of value if they can't be operated without an expensive
permit. In that light, it doesn't seem so unreasonable
to ameliorate their losses by letting them have the permits
at a deep discount.

There are good arguments in both directions here, but
Professor Mankiw has failed to engage with any of them. Let me try
to point out the issues that he and so many other economists
have overlooked.

The primary goal of cap-and-trade is to make firms behave
better in the future, and as Professor Mankiw points out,
that goal is served equally well whether we give the permits
out for free or require firms to buy them. But the latter
option not only creates an incentive for good
future behavior; it simultaneously punishes
bad past behavior. The firm that recently invested
in a million-dollar machine that now can't be operated without
a half-million dollar permit is effectively paying a
half-million dollar fine for behavior that was perfectly legal
a year ago.

The larger question, then, is this: When people do things
that are socially destructive but nevertheless perfectly
legal (like, say, owning slaves in the 19th century or
leaving an excessive carbon footprint in the 21st),
ought they be punished ex post facto? The answer is
far from obvious.

There are two competing principles here. The first
principle is: Nor shall private property be taken for
public use without just compensation, a principle
enshrined in our Bill of Rights. Arguably, in the case
of the million-dollar machine, the government has effectively
taken half your machine from you for the public purpose of
cleaning the air; therefore you should be entitled to just
compensation. One form of compensation would be to give
you your permit for free.

(Actually, a free permit amounts to overcompensation,
because cap-and-trade will lead to higher prices for
carbon-based products, which already partly compensates
the affected firms. So maybe our principle dictates
that permits should be cheap but not free.)

This is the principle that justifies job retraining
programs for displaced workers. Like slaveholding and
overpolluting, working in a tariff protected industry is
socially undesirable even when it's perfectly legal:
You really oughtn't be overcharging your neighbors for
goods they could get cheaper from overseas. When we put
an end to your bad behavior with a free trade agreement,
we simultaneously punish you by devaluing your job
skills. A lot of people think we should ameliorate that
punishment by giving you some training. That's a lot
like ameliorating the effects of cap-and-trade by giving
out free (or cheap) permits.

But here's the countervailing principle: Bad behavior
---even legal bad behavior---should be punished
eventually, because that precedent deters future bad
behavior. If that principle were applied consistently
and predictably,
firms might not have overinvested in the wrong
technologies to begin with. That's partly why we didn't
compensate the slaveholders when we freed the slaves; we
wanted to send the message that you really shouldn't
have been holding slaves in the first place.

One problem with applying this principle is that a
government with the power to punish bad behavior
ex post facto is also a government with the power to
punish good behavior ex post facto. If today they can
retroactively punish overinvestment in bad technologies by making
people buy cap-and-trade permits, then perhaps tomorrow
they can retroactively punish saving by taxing our 401Ks. The
fact that a principle is capable of being abused does not
invalidate the principle, but it does suggest we might want
to be cautious about invoking it.

In this case, I'm not sure which principle should
prevail. I am, however, sure that these are the
principles at stake, and any useful debate will have to
address them.

That's why I'm so disappointed to see am economist as smart
as Professor Mankiw arguing in essence that we
should sell cap-and-trade permits just because it's a good
way for the government to get its hands on a big pile of
money.
The fact is that the
government does not lack for opportunities to get ahold
of big piles of
money. It could go ahead and tax those 401Ks, or
confiscate them altogether. For that matter, it could
confiscate all our houses and make us buy them back.
That would raise plenty of revenue, but it's still a bad
policy.

The real question on the table is:
Do we want to
empower our government to punish bad behavior that was
perfectly legal when it occurred? If you answer one
way, you'll favor compensation for slaveholders,
retraining programs for displaced workers and free (or
at least inexpensive) cap-and-trade permits for
polluting firms. If you answer the other way, you'll
reverse those judgments.